Employee pensions are confusing.  That’s been highlighted by the reaction to the recent announcement that the National Insurance contributions (NICs) benefits of pension salary sacrifice will be heavily limited from 2029.  The press coverage on this tended towards the apocalyptic.  So what’s really happening when these changes come in and what sort of action might employers take to prepare?

This article also considers what else employers should be thinking about.  We see lots of employers make inadvertent payroll errors with their employee pensions.  When these are compounded over years it can give rise to a hefty tax bill and / or damage the relationship with employees.

“Salary sacrifice” and misconceptions from the Autumn Budget

Under a “salary sacrifice” arrangement, employee pension contributions are deducted from earnings before deductions for PAYE and NICs, allowing full relief at source.

In the most recent Autumn Budget, Rachel Reeves announced a cap on the NICs saving available through pension salary sacrifice, so that that from 6 April 2029 only the first £2,000 per year of employee pension salary sacrifice will be exempt from both employee and employer NICs.

There seems to be fairly widespread misunderstanding about the impact of this change.  To help bust a few myths…

1. Nothing is happening immediately – the change will be effective from 6 April 2029.
2. The change does not cap pension contributions at £2,000.
3. The change does not limit income tax relief on pension saving to £2,000.
4. There will be no impact on employer pension contributions, or any other aspects of pension taxation.

If it’s helpful to think about the actual impact in financial terms I gave some practical examples in my earlier article on the topic (available here).

While the change will reduce the advantages of salary sacrifice for both employees and employers, salary sacrifice remains the most tax efficient way to make employee pension contributions.  But it’s definitely going to get a bit more fiddly to operate when the NIC changes come into effect, so employers are entitled to ask: is it worth the hassle?

What should employers be doing?

Given that the changes aren’t coming in for a while, employers have the luxury of taking a step back and assessing their pension arrangements.  For some this might prompt an attempt to consolidate different pension arrangements that have accumulated over the years (e.g. from business acquisitions).

Even if you only have one pension provider and employees are all on broadly the same arrangements, you might want to consider alternatives, especially if salary sacrifice no longer seems ‘worth it’.

Alternative 1: “Net pay” payroll arrangements

Under a (confusingly named) “net pay” arrangement, employee pension contributions are deducted from earnings before deduction for PAYE, allowing income tax relief at source.  There is no NIC relief.

Clearly the lack of NIC relief means that this is a less advantageous arrangement than salary sacrifice.

However, given a net pay arrangement can be slightly easier to implement we might reasonably see an increase in the use of this arrangement from 6 April 2029, where the NIC benefit of salary sacrifice arrangements will be limited to £160 per year for employees and £300 per year for employers.

Alternative 2: Standard “Relief at source”

The (almost even more confusingly named) “relief at source” arrangement is one where employee pension contributions are deducted from net earnings after deduction for PAYE and NIC.  The pension provider then applies a “gross up” to give basic rate tax relief, with any further tax relief needing to be claimed from HMRC (either by contacting HMRC or filing a tax return).

The lack of NIC relief together with this second step to claim any higher/additional rate income tax relief means that these arrangements are the least favourable for employees.  However, their existence endures as they are often the preferred (or at least default) approach for many pension providers.

Common errors and remedial actions

Given the variety of options available it is perhaps unsurprising that mistakes are made.

One of the more common errors we see is where employees inadvertently benefit from “double” tax relief, through a combination of (i) tax relief through payroll, together with (ii) a tax gross up processed by the pension provider.

In practice this can happen where an employer switches payroll or pension providers, or sometimes in the transition that follows a business acquisition.

In such cases, employers will likely need to engage with pension providers to reverse excess contributions and payroll providers to correct submissions. They may also even need to recover underpaid tax from employees.  For obvious reasons this exercise is something most businesses will want to avoid, and so it is important they understand how their existing payroll arrangements operate in practice. Another common error is information not being passed to the pension provider and/or the payroll provider, which could lead to pension contributions being missed altogether.

The key thing is to understand how your pension works and make sure that your payroll operation and the information you send to the pension provider every month is consistent.  Is it full salary sacrifice, or a mix of employer contributions with either ‘net pay’ employee contributions or ‘relief at source’ employee contributions?  If you identify any discrepancies between your payroll and your communications with HMRC or the pension provider it’s always better to fix them sooner rather than later.

Please get in touch if you want to discuss your existing pension arrangements or how to respond to the changes to the salary sacrifice rules.